energy situation

This is Part Two of a three part series on China’s energy challenge. This series arises from the White Paper on China Energy Policy 2012 that the PRC State Council put out last month, right before the 18th Party Congress. The White Paper sets out China’s current situation and then maps out China’s energy plans for the ten-year term of the new leadership to be installed at the party congress.

In Part One, I set out China’s energy scenario. In this Part Two, I will analyze the White Paper itself. In Part Three, I will discuss how China’s energy challenge is likely to impact foreign companies doing business with China or in China.

The White Paper starts by providing data that shows that China’s energy consumption has increased dramatically over the past five years:

Primary energy consumption has increased by 31%

Natural gas consumption has increased by 110%

Electricity consumption has increased by 60%.

Not only has China’s energy consumption increased, but the government predicts that the rate of increase will accelerate over the next decade as China develops rural areas and the Central and Western regions. An additional issue is that the rate of increase will be especially great for petroleum and natural gas, fossil fuels that will start to displace coal in the national energy mix.

China is the world’s largest producer of both coal and hydroelectric power. For that reason, even in 2011, China was able to maintain a domestic self-sufficiency in energy of about 90%. However, production of coal and hydropower have natural limits and China’s shift to petroleum and natural gas in expected to substantially increase. This will make maintaining self-sufficiency in energy progressively more difficult for China over the next decade.

With this factual scenario as the background, the White Paper identifies the following five specific challenges for China’s energy future:

Consumption growth. China’s per capita energy consumption is low by world standards. Continued rapid growth in energy consumption is to be expected.

Low energy efficiency. China’s energy consumption per unit of GDP is higher than developed country standards and is even higher than some recently industrialized economies comparable to China.

Increasing environmental pressure. China’s wasteful use of energy results in substantial pollution of air and water. This is more than an economic problem. It negatively impacts the lives of all Chinese people.

Energy security. As China shifts away from coal as the primary fossil fuel, dependency on foreign sources of energy is increasing. For example, in the past five years foreign supply of petroleum has increased from 32% to 57%.

Systems and mechanisms. China’s existing systems and mechanisms for energy production and pricing are weak. This is particularly true the pricing for energy products. These pricing issues then make it difficult to develop a rational domestic energy production program, especially in those areas where domestic and non-domestic prices are substantially different.

The White Paper then goes on to describe in very general terms the areas within China’s energy sector where the government will focus to address these five challenges:

Conservation. Over the past five years, China focused on energy conservation with the goal to reduce China’s ratio of energy use to GDP growth to .5 to 1. Though the White Paper does not explicitly discuss this, this policy has failed. As I noted in Part One of this series, China’s current ratio of energy use to GDP growth remains at about 1 to 1 ratio and there is no indication that ratio will improve in the next decade.

New and renewable energy sources. Like every other country in the world, China is focusing heavily on renewable energy. Like every other country in the world, even if China succeeds in its most ambitious renewable energy plans, the results are likely to be negligible.

Clean fossil fuels. This is a major challenge in China due to its extensive use of coal in electrical and industrial production.

Provision of universal energy service. If this program is successful, energy consumption will increase by a substantial amount.

Improved energy technology. The White Paper repeats the usual platitudes about increasing domestic innovation in energy technology, but fails to discuss in any real detail how this will be funded or the expected timeline for results.

Industrial reform. A major factor in China’s high use of energy is that its economy is still substantially skewed towards heavy industry. A shift towards more “high tech” and service sector businesses will result in an economy with decreased raw energy consumption. The White Paper does not explain how this economic shift will occur, nor does it discuss the probability of any impact occurring within the next decade.

Increased participation in international energy markets. For many years, China was able to rely on its domestic energy consumption for its economic development. This era is now over. China will now need to actively participate in international energy markets, both in terms of purchasing product and in terms of securing supply. This involves a whole set of commercial, technical and political challenges for which the state owned Chinese oil companies are ill-prepared.

What the White Paper shows is this: The Chinese government is very clear that energy production and consumption will impose major challenges for China GDP growth over the next decade. However, in reading the White Paper, it is clear that the Chinese government has little idea on how to address those challenges. In that sense, the Chinese government is not that much different from any other government in the world. The problem for China is that in the developed world the challenges are not being addressed solely or even primarily by governments; for the most part, the challenges are being addressed by private businesses. Without private business to provide the risk taking and innovation, it is difficult to see how China or any other command economy will deal with these issues over the next decade.

In Part Three, I will address how China’s energy issues are likely to impact foreign companies doing business in China.

In October of this year, the Information Office of the PRC State Council published its White Paper on China Energy Policy 2012. The White Paper outlines the current state of energy production and consumption in China and China’s future energy plans. Since energy is critical to economic growth in any country, it is worth taking some time to consider China’s energy challenge. The White Paper is particularly significant because it was released immediately before the 18th Party Congress. The White Paper sets out China’s current energy situation and then maps out its energy plans for the ten-year term of the new leadership to be installed at the party congress.

In this Part One, I set out China’s energy scenario. In Part Two, I will analyze the White Paper itself. In Part Three, I will discuss how China’s energy challenge is likely to impact foreign companies doing business with China or in China.

Before turning to the White Paper, let’s consider China’s basic energy situation using data from the BP Statistical Review of World Energy June 2012 and the CIA’s World Fact Book. The most important fact is that in 2011 China became the largest consumer of energy in the world. In 2011, China consumed 21.3% of world primary energy. In that same year, the United States was the second largest consumer, taking 18.5% of world primary energy.

Note however that in 2011, the Chinese GDP was less than half of that of the United States. According to the CIA, U.S. GDP was about $US 15.0 trillion. In nominal terms, the Chinese GDP was $US7.2 trillion. That is, the U.S. economy was slightly more than twice as large as the Chinese economy. On the other hand, U.S. energy usage was only 86% as large as that of China. Stated simply, China used substantially more energy than the U.S. to produce less than half the economic output.

Consider this issue from the standpoint of economic growth. During the year 2011, China’s GDP grew at a rate of 9.2%. During that same year, China’s consumption of primary energy grew at a rate of 8.8%. Using rough numbers, we can say that for every 1% of economic growth, China’s economy required a 1% increase in energy consumption in 2011. This ratio of energy to GDP growth has been fairly consistent for the past decade in China. We can therefore say that under China’s current pattern of production and growth, this ratio will probably remain the same for the next decade of growth.

Now consider the issue facing Chinese economic planners. It has been a commonplace to claim that China’s GDP will reach the level of the U.S. GDP sometime in the next decade. If we use the CIA numbers, this prediction means China’s GDP will grow to about 2.5 times its current size within the next decade. Applying the one to one ratio of 2011, that means China’s consumption of energy will also need to grow to about 2.5 times its current size to fuel that increase in GDP.

Consider now what that increase in energy consumption would mean. In 2011, China consumed 2,623 million tonnes oil equivalent (MTOE). The world consumed 12,274 MTOE. If China’s economy grows 2.5 times larger, its energy consumption would increase to 6,533 MTOE. That is, China alone would consume over 50% of the current total energy consumption of the entire world. In order for this to happen, one of two things would have to occur. Either all the other countries in the world would be required to substantially decrease their energy consumption, or the entire world production of primary energy would need to increase by over 50% in a ten-year period. If other developing countries grow at a rate even close to that projected for China, even this 50% number would need to increase by a substantial rate.

This then leads to the energy dilemma. No one believes that the countries of the world will reduce their own consumption of energy simply to make room for increased Chinese consumption. And no one believes that it is possible to increase world primary energy production by over 50% in a ten-year period. This then means that under current conditions, the projected growth of the Chinese economy is simply impossible. There is not enough energy available to fuel that growth.

This is China’s energy challenge and the White Paper was written with this stark challenge as a background. For many reasons, China must continue to grow its GDP. However, if China does not make major changes to its current system, energy constraint will make that growth impossible. These are not constraints that will have an impact in the distant future; they are constraints that will have an immediate impact. Thus, the new leadership of China must address these issues immediately.

The purpose of the White Paper is to address these issues. Like most government based energy policy statements from around the world, the White Paper avoids providing any clear statistics outlining the real issues. It instead portrays the issues and the proposed solutions in purely qualitative terms. This suggests either that 1) the issues are not fully understood or 2) the problems are so intractable that a factual discussion would lead nowhere. This is typical of world governments and should come as no surprise.

Stay tuned….

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